Understanding Interest-Only Mortgages
An interest-only mortgage allows you to pay only the interest each month, which typically results in lower monthly repayments. However, you do not reduce the loan principal during the mortgage term.
How Interest-Only Mortgages Work
With this type of mortgage, monthly payments cover just the interest, meaning the full loan amount remains outstanding until the end of the term. At that point, you must repay the entire borrowed amount in one lump sum.
How Repayment Mortgages Work
In contrast, repayment mortgages require you to pay both the loan principal and interest each month. This gradually reduces your loan balance over time, ensuring the full loan is paid off by the end of the term.
Key Differences Between Interest-Only and Repayment Mortgages
- Interest-only payments are usually lower than repayment mortgage payments of the same size.
- Repayment mortgage payments are higher as they include both principal and interest.
- You pay more interest overall with an interest-only mortgage because the loan balance stays the same during the term.
- Repayment mortgages result in less overall interest because the loan balance decreases monthly.
- Interest-only mortgages carry a higher risk of negative equity since the original loan balance doesn't reduce.
- Repayment mortgages have a lower risk of negative equity because your debt gradually decreases, and you build equity in your property.
"You only pay the interest each month, so your monthly repayments are usually lower."
"At the end of the mortgage term, you’ll still owe the full amount borrowed and will need to repay it in one lump sum."
"You’ll pay more interest overall because the loan balance doesn’t reduce during the term."
"Lower risk of negative equity, since you reduce your debt over time and build equity in your property."
Summary
Interest-only mortgages offer lower monthly payments but come with higher overall interest costs and greater risk, while repayment mortgages provide gradual debt reduction and equity building at the cost of higher monthly payments.